Daily Newsletter, Saturday, 7/20/2019

Table of Contents

Market Wrap

Uncertainty Is The Only Certainty

by Thomas Hughes

The indices ended the week on a sour note. Iran sparked a sell-off that left the broad market down by -0.60% at the end of the day Friday and down -1.3% for the week. While Friday's move was sparked by Iran's seizing a UK-flagged tanker the move for the week is driven by mounting uncertainty. The only thing to be certain of is the uncertainty and that is a bad bad thing for a market trading at all-time highs.

Hope has driven the S&P to its current levels if reality doesn't meet up to the expectation I fear a deep, deep correction will come. The top of the list this week is the FOMC. The market has built up an expectation for deep FOMC rate cuts and there is absolutely no guarantee one will come. While Jerome Powell's testimony to Congress and John William's off-the-cuff comments suggest the FOMC is going to cut rates aggressively the data just doesn't support it.

This week's data isn't robust but neither is it poor. On balance, the data is still solid and points to a steadily growing U.S. economy. The retail sales figures were strong and confirm consumer expectations arising from the last NFP report; strong job and wage gains = a healthy consumer. Consumer Sentiment data was also good. Consumer Sentiment missed expectations but still posted an increase over the last month.

The NAHB Home Builders index was also solid. There is still some weakness in traffic but the traffic that's there is converting to sales. All three sub-indices gained in the last month, sales and outlook for sales are both above 70 and at what I will call robust levels. Housing starts were also good but offset by weak permits. Permits are an indication of future starts so this is a potential red-flag.

Jobless claims were also good, initial and continuing claims are trending near their 5-decade lows and edged lower over the last week. There is still some volatility in the data but it seems to be quieting down. The total claims data persists in its signal as well, the total claims did not retreat as much as expected this season and suggests an end to market tightening. Because the slack is gone, there is no need for the Fed to do anything about rates because of labor.

The Philly Fed's MBOS was fantastic. The MBOS rebounded 21.5 points from last month's tepid 0.3 to 21.8. The rebound is driven by an increase in new orders, shipments, demand, employment, future expectations, and prices. Employment rose 15 points to 30, its highest level since December 2017. Prices, inflation, rose as well. Current prices received rose 9 points to 9.5 while the Prices diffusion index gained 3 to hit 16.1. Based on this the Fed doesn't need to act aggressively or swiftly to prop up manufacturing, looks pretty good to me.

The only negative in terms of the data and the FOMC outlook was the import/export price indices. Both fell, export prices more than forecast, and that does suggest the FOMC might want to lower rates. Even so, this data is offset by the MBOS and does not suggest the Fed need to act aggressively if it does choose to act.

The Beige Book confirms economic activity continued to expand at a modest pace from mid-May through early July, with little change from the prior period. The outlook is generally positive for the coming months, with expectations of continued modest growth, despite widespread concerns about the possible negative impact of trade-related uncertainty.

The Beige Book also indicates the rate of price inflation was stable to down slightly from the prior reporting period. Districts generally saw some increases in input costs, stemming from higher tariffs and rising labor costs. While the inflation data is weakening it has by no means reached the point where the Fed has to act. A preemptive move might be necessary, it would absolutely play into Trump's hands and I don't think Powell is keen to do that regardless what the FedWatch Tool is indicating.

The FedWatch Tool is still predicting a 100% chance for a 25 BPS cut in July and I think that is too high. The odds for a 50 bps point rate cut are close to 20% but down from near 40% just after William's remarks Thursday. The odds for 75 bps by December is near 70% now and that is way too high. With the data already firming a single cut is likely all the economy will need, if that. We may get a cut this month but I think the outlook for future cuts is going to fall short of expectations.

The next FOMC meeting is in eleven days, the risk for traders in that time is the data. Next week's calendar is not full by any means but there are some potentially market-moving events. On Monday the Chicago National Activity Index will be watched for confirmation of economic rebound over the past month. On Tuesday Existing Home Sales are expected to hold steady or fall slightly. On Wednesday we'll get flash readings on PMI, services, and manufacturing, along with New Home Sales which are expected to rise by 2.2%. Thursday is jobless claims as usual but the big economic news of the week will come Friday.

Friday is the first estimate for the 2nd quarter GDP. The 2nd quarter GDP is expected to fall to 2.1% from 3.1% in the first quarter. It may turn out to be a dud but I think a miss or beat on this figure will have a big impact on the market. A miss will reinforce hopes for aggressive rate cuts and fears of global economic slowing; a beat will reduce hopes for aggressive Fed action and the stability of U.S. Fundamentals despite the trade war.

As if the FOMC isn't enough for the market to worry about there is still the trade war. The way it stands now, the best the market can hope for is Trump and Xi can maintain the status quo. While Mnuchin says the two sides are getting close to holding face to face talks again the sticking points remain and Huawei is at the center of it. And there is still the as-yet unratified USMCA, a slowly escalating trade-situation with the EU, the Brexit, issues between Japan and South Korea, general political instability within the EU, escalating tensions in the Middle East, and their effects on earnings growth to worry about.

Earnings Season Scorecard

The earnings cycle is well underway although it is still early in the season. So far 16% of the S&P 500 have reported and the results are good. The blended rate for growth has risen to -1.9% from last week's -3.0% which is great. At this rate, earnings growth is likely to turn positive by the end of the reporting season. Six of the eleven sectors are beating consensus with an average per-company beat of 7%. If this rate keeps up we should see earnings growth top 3% by the end of the cycle but I'm not holding my breath. There are still a lot of companies to report, next week there are 144 on the list including 1/3 of the Dow Jones Industrial Average.

Despite the strength in this quarter's earnings the outlook for future earnings continues to decline. The outlook for all four of the following quarters fell an average -0.75% which is a big blow to expectations. The way things are going I expect the outlook earnings will sour over the course of the season. At the current rates of decline, the outlook for EPS growth in the 3rd quarter will be mid-single digits and the 4th's will be low single digits. The good news is that growth is still in the forecast. Although those estimates are falling as well, growth should re-accelerate next year.

Microsoft reported last week and beat on the top and bottom lines. The company says revenue grew 12% YOY driven by a 64% increase in Azure revenue growth. Cloud computing has been driving Microsoft's strength in recent years so analyst were sure to point out Azure growth decelerated from last quarter's 73%. Regardless, the company posted solid gains in all segments and spent less on CAPEX than expected.
Microsoft guided earnings outlook higher after the report and that helped shared rise by more than 2.0%. The bad news is the analysts were expecting more and the highs weren't sustained. Company guidance is a range with consensus in the middle which is OK but not great. The analysts at BMO, Raymond James, and Canaccord Genuity raised their price targets to an average $159.30 in response to the news, an 11.70% to Friday's close. The caveat is the candle, Friday's candle is not pretty and may lead to a better buying opportunity.

American Express also reported better than expected earnings and failed to impress investors with guidance. The company says weakness in consumer was offset by strength in commercial segments for a net increase in merchant services income. The company only reaffirmed its guidance despite the strength, no increases, and the stock fell on the news. Investors were hoping for a better indication of the future and they didn't get it. The $124 level may be a good entry point, but it may also be a good selling point. The indicators are bearish and suggest support is going to be retested; if the $124 level breaks down a move to $120 could come forthwith.

Schlumberger reported revenue is slightly above expectation with EPS inline with consensus. The company says North American weakness is offset by International strength and that is expected to continue in the foreseeable future. Spending in the International segment is expected to increase 7-8% while that in the U.S. is expected to fall -10.0%. The news sparked some volatility in the stock, shares fell hard on the news but found support at $38. At these levels, the 5.20% dividend rate is attractive although there is some risk of a distribution cut.

Sketchers jumped more than 9.0% after it reported strong numbers and raised its guidance. The global shoe company says sales are up 10.9% with high single-digit comps at its U.S. stores. International wholesale is the strongest performing sector surprisingly enough and up 18%. Direct to consumer is up strongly at 14.4% but U.S. wholesale saw a small decline. Regardless of the breakdown, the brand's organic strength and expansion plans are driving revenue and EPS gains and that is what counts.

Results were mixed among the transportation companies that reported last week. Union Pacific and CSX both missed on the revenue side and CSX at least provided weak guidance. Trucking/Intermodal operator JBHT reported revenue in line with consensus and a small EPS miss. Comments from JBHT and UNP during the conference calls settled some market fears, those stocks were able to hold steady or rally, CSX tanked on its results and closed the week with a loss near -12.5%.

Netflix reported revenue in line with consensus and EPS was slightly ahead of expectations. Then it shocked the market saying subscriber growth was only 2.7 million, about half the expected and last year's gain. The news was not taken well and sent shares down more than -10% despite a net annual subscriber gain of 21.9%. One reason for the decline is content, Netflix lost some key content over the last year and that is dragging on subscriptions. Looking forward, NFLX is expecting Q3 gains to make up the loss as new shows come online. The rest of FAANG will report over the next ten days.

The Indices

The indices do not look good. All three majors hit new all-time highs last week and all three saw those highs rejected. The Dow Jones Transportation is not at an all-time and yet it too saw its price move rejected. The transports formed a fairly large doji candle and it is showing resistance and uncertainty at what could be a crucial level for the index. If the index moves higher great, if not it will be forming a Head & Shoulders and confirming previously strong resistance. Resistance is just above 10,750 and the near the December 2018 highs. The fact the Transports are not at new highs while the Industrials are is one red flag, the fact the transports are showing resistance at such a critical level is a second.

The Dow Jones Industrials posted the smallest loss last week but the candle is no less bearish. The index is hanging at a new all-time high showing a bearish candle pattern, not quite a Piercing Pattern, with overbought conditions and divergent MACD. The MACD isn't just a little bit divergent either, it is highly divergent and highlighting weakness in the market. The blue chips may not fall from this level but it certainly doesn't look like a time to buy.

The tech-heavy NASDAQ Composite posted a weekly loss of 1.18%. The candle is forming a Bearish Piercing Pattern and suggest a small correction at least is on the way. The indicators are set up in such a way to make me think the correction could be large when it does come. The MACD is already divergent from the new all-time high and shows a definite weakness in the market. the stochastic is still moving higher so may not diverge but, if the index falls, will confirm divergence.Once the selling starts the initials declines could be big and those big enough to trigger follow-on selling.

The S&P 500 shed -1.20% last week. The candle formed is a Dark Cloud Cover. The indicators are consistent with a peak in prices and set up for a strong downdraft once the selling starts. The MACD here is also divergent and showing a serious lack of substance in the recent rally. Stochastic is still moving higher but set up to show a major divergence if the index were to fall from this level. The 2940 level is the first and most obvious level of potential support, the previous all-time high, and may be strong enough to hold the market up. If it fails a move to 2,750 is possible.

The indices may not correct but that is not something I can trade on. There is too much uncertainty in the market and that uncertainty is shining through in the charts. The indices have been drifting higher on hopes and allowed to hit new highs because of a "wait and see" mentality, now it's time to face reality. Earnings are being reported, new data is coming in, and the FOMC is about to meet so there is a lot of reality to face.

The earnings, at least, are better than expected and that is good, fingers crossed the season continues on that way. What I'm worried about is the FOMC. The market has a lot of expectation baked into that cake and I think it is going to be deeply disappointed in how it turns out. The next FOMC meeting is in 10 days.

Until then, remember the trend!

Thomas Hughes

New Plays

Russell Rout

by Jim Brown

There is a good chance we are going to see a breakdown in the Russell soon. The index finally broke short term support to close at a three-week low and the odds are good we are going to see a breakdown going into August. That is the weakest month of the year.

The IWM is the ETF for the Russell 2000 and includes all 2,000 companies in that index. It tends to mimic the index and options are cheaper because of the smaller range of movement.

The Russell closed at a three-week low after failing to move higher while the Dow, S&P and Nasdaq were making new highs. With August normally the worst month of the year and the Fed rate cut already priced into the market there is a good chance the Russell could lead the market significantly lower.

In Play Updates and Reviews

Slip Sliding Away

by Jim Brown

Small caps continue to be weak and the outlook is fading. The Russell 2000 closed at a three-week low with a -1.4% decline for the week. The small cap internals are worsening and nearly every small cap stock is fading.

Current Portfolio

Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow.
We need to always be prepared for an unexpected decline.

Profit Targets

Check the graphic below for any profit stops in green.
We need to always be prepared for a profit exit at resistance.

Current Position Changes

BBBY- Bed, Bath and Beyond
The short position was entered at the open on Monday.

Needham analyst Vincent Yu estimates that LK grew its revenue in Q2 by 85% with the net addition of 4.4 million new customers. That would bring the customer base to 21.3 million. If the company posts those metrics when they report earnings on August 14th it will be a blowout.

Original Trade Description: June 16th.

Luckin Coffee Inc. engages in the retail sale of freshly brewed drinks and pre-made food and beverage items in the People's Republic of China. It offers freshly brewed drinks, including freshly brewed coffee and non-coffee drinks; and food and beverage items, such as light meals. The company operates pick-up stores, relax stores, and delivery kitchens under the Luckin brand, as well as Luckin mobile app, Weixin mini-program, and other third-party platforms that cover the customer purchase process. As of March 31, 2019, it operated 2,370 stores, including 2,163 pick-up stores, 109 relax stores, and 98 delivery kitchens in 28 cities in the People's Republic of China. The company was founded in 2017 and is based in Xiamen, the People's Republic of China. Company description from FinViz.com.

The company is being called the Starbucks of China because there will be a store on every corner. They expect to grow from 2,400 stores in April to 5,000 stores by the end of 2019.

They sell coffee a lot cheaper than Starbucks and are heavy into spiced teas which are popular in China. The stores are small format and only seat 8-12 people with the idea being that Chinese people are always in a hurry. They do not accept cash. All purchases must be made through their app and that allows the company to constantly push coupons to their customers. Sales are expected to rise 3,000% by 2021. Market share is expected to grow from 1% to 23% over the same period according to Morgan Stanley.

Last week the Qatar Investment Authority disclosed they had acquired a 3.25 million share position post IPO of 8.81%. Capital Group, a unit of Capital research Global Investors disclosed they had acquired a 5.8 million share block or 15.6%. Carob Investments, a unit of Singapores soverign wealth fund GIC Private bought a $45 million stake representing a 13.04% ownership position. Hedgefunds Melvin Capital acquired a 1.7 million share stake and Darsana acquired a 34.4 million Class A share stake or 11.12%.

With all these large investors buying large positions which will not be traded, it is shrinking the float and could create some volatile moves as other companies try to follow their lead.

No earnings date available.

Needham rates Luckin a buy with a price target of $27. With a shrinking float any positive news can send shares sharply higher.

Update 6/23: LK announced that the IPO was oversubscribed, and the underwriters took their full allotment of 4.95 million shares at the IPO price of $17. Shares declined -3% on the news.

Position 6/17:
Long LK shares @ $19.68, see portfolio graphic for stop loss.

No specific news. Shares fell sharply on Monday on no news to stop us out of the stock position. The option position is still active.

Original Trade Description: July 6th

Synchronoss Technologies, Inc. provides cloud, digital, messaging, and Internet of Things (IoT) platforms, products, and solutions in North America, Europe, the Middle East, Africa, Latin America, and the Asia Pacific. The company's platforms, products, and solutions include digital experience management platform as a service, which includes digital journey creation and journey design products that use analytics that power digital advisor products for IT and business channel owners; and cloud sync, backup, storage, device set up, content transfer, and content engagement for user generated content. Its platforms, products, and solutions also comprise multi-channel messaging peer-to-peer communications and application-to-person commerce solutions; and IoT management technology for smart cities, smart buildings, automotive, and others. In addition, the company offers software development and customization services. Its products and platforms enable multiple converged communications, commerce and applications, and devices to deploy across a range of distribution channels, such as e-commerce, m-commerce, telesales, retail stores, and care and call centers, as well as self-service, indirect, and other outlets. The company markets and sells its services through direct sales force and strategic partners. Synchronoss Technologies, Inc. was founded in 2000 and is headquartered in Bridgewater, New Jersey. Company description from FinViz.com.

On June 6th, SNCR held an investor day and gave better than expected earnings guidance, plans to invest $20-$25 million on capturing future growth opportunities and reiterated its revenue guidance of $340-$355 million and adjusted EBITDA of $30-$40 million after those investments. This was a shock to the analysts in attendance. Shares rallied about 15%.

On June 18th, Roth Capital analyst Richard Baldry initiated coverage with a buy rating and $13 price target. SNCR was trading at $6.67 at the time. That price target was a 95% premium to the prior close. The analyst said SNCR had a "unique set" of cloud based products that cater to "important new strategic growth avenues for a broadening set of potential customers." Shares rallied $2 from the $6.66 close.

Since that analyst coverage, shares have been moving higher and closed at a 14-month high on Friday. Their all time high was near $50 and nobody expects them to reach that level in the near future but it does prove they can evolve after a year in the dumps.

If they break over the $8.50 level we could see a run to resistance at $12 in the near future.

Intrexon Corporation engages in the engineering and industrialization of biology in the United States. The company, through a suite of proprietary and complementary technologies, designs, builds, and regulates gene programs, which are DNA sequences that consist of key genetic components. It provides reproductive technologies and other genetic processes to cattle breeders and producers; biological insect control solutions; technologies for non-browning apple without the use of artificial additives; genetically engineered swine for medical and genetic research; commercial aquaculture products; and preservation and cloning technologies. The company also offers UltraVector platform that enables design and assembly of gene programs that facilitate control over the quality, function, and performance of living cells; and RheoSwitch inducible gene switch that provides quantitative dose-proportionate regulation of the amount and timing of target protein expression. In addition, it provides AttSite Recombinases, which allows stable, targeted gene integration and expression; LEAP automated platform to identify and purify cells of interest, such as antibody expressing cells and stem cells; ActoBiotics platform for targeted in situ expression of proteins and peptides from engineered microbes; and AdenoVerse technology platform for tissue specificity and target selection. The company serves the health, food, energy, and environment markets. Intrexon Corporation has collaboration and license agreements with ZIOPHARM Oncology, Inc.; Ares Trading S.A.; Oragenics, Inc.; Intrexon T1D Partners, LLC; Intrexon Energy Partners, LLC; Intrexon Energy Partners II, LLC; Genopaver, LLC; Fibrocell Science, Inc.; Persea Bio, LLC; OvaXon, LLC; S & I Ophthalmic, LLC; Harvest start-up entities; and Surterra Wellness. The company was formerly known as Genomatix Ltd. and changed its name to Intrexon Corporation in 2005. Intrexon Corporation was founded in 1998 and is based in Germantown, Maryland. Company description from FinViz.com.

Intrexon just announced a deal with Surterra Wellness to produce cannabinoids using the Intrexon yeast fermentation technology. This is the second deal between the two companies. In March, Surterra licensed Intrexon's Botticelli plant propagation technology to improve cannabis crop yield and quality.

In the current deal Intrexon will receive $100 million over time including $15 million in Surterra shares. The cash will help on the cash burn problem. Intrexon had $181 million in cash at the end of March. Intrexon has dozens of products and technologies in the process of being commercialized.

In May and early June, the CEO bought 6 million shares in the open market in about 35 transactions. That is a roughly $30 million investment in Intrexon and as CEO he should know what is coming for the company.

No specific news. Goldman initiated a sell rating with an $11 target but shares have already broken under $10 to a new low.

Original Trade Description: May 25th

Bed Bath & Beyond Inc., together with its subsidiaries, operates a chain of retail stores. It sells a range of domestics merchandise, including bed linens and related items, bath items, and kitchen textiles; and home furnishings, such as kitchen and tabletop items, fine tabletop, basic housewares, general home furnishings, consumables, and various juvenile products. It also provides various textile products, amenities, and other goods to institutional customers in the hospitality, cruise line, healthcare, and other industries. As of March 2, 2019, the company had a total of 1,533 stores, including 994 Bed Bath & Beyond stores in all 50 states, the District of Columbia, Puerto Rico, and Canada; 277 stores under the names of World Market, Cost Plus World Market, or Cost Plus; 124 buybuy BABY stores; 81 stores under the Christmas Tree Shops, Christmas Tree Shops andThat!, or andThat! Names; 55 stores under the Harmon, Harmon Face Values, or Face Values names; and 2 two retail stores under the One Kings Lane name. It also offers products through various Websites and applications, such as bedbathandbeyond.com, bedbathandbeyond.ca, harmondiscount.com, facevalues.com, christmastreeshops.com, andthat.com, buybuybaby.com, buybuybaby.ca, harborlinen.com, t-ygroup.com, worldmarket.com, ofakind.com, onekingslane.com, personalizationmall.com, chefcentral.com and decorist.com. In addition, it operates Of a Kind, an e-commerce Website that features specially commissioned limited edition items from emerging fashion and home designers; One Kings Lane, an authority in home decor and design that offers a collection of selected home goods, and designer and vintage items; PersonalizationMall.com, an online retailer of personalized products; Chef Central, an online retailer of kitchenware, cookware, and homeware items catering to cooking and baking enthusiasts; and Decorist, an online interior design platform. The company was founded in 1971 and is based in Union, New Jersey. Company description from FinViz.com.

Bed Bath and Beyond reported "adjusted" earnings of 12 cents, down from 38 cents in the year ago quarter. For GAAP earnings they lost $2.91 per share on revenue of $2.57 billion. The company took an impairment charge of $401 million, only slightly better than the $500 million charge in the prior quarter. Sales declined 6.5% year over year but are down -44% for the last 12 months. Needless to say, they missed all the estimates.

Analysts claim the stores are understaffed, have shrinking inventory and declining market share. Competition with Target, Walmart and Amazon is proving to be nearly impossible. The new CEO of two months has a herculean task ahead of her and she knows it. She said in order to compete "we need to give consumers a reason to keep shopping in our brick and mortar stores and in order to do that we need to update the stores and enhance the shopping experience." Unfortunately, that costs money and unless consumers drop in, they will never know anything has changed.

BBBY is heading the way of dozens of other retailers. They are following the path of Sears where inventory became nonexistent and salespeople even scarcer. Shares closed at a multiyear low and more than likely will move lower.

The 22.5 level has become new support. We will need a new surge in equities to break that level.

Original Trade Description: Nov 17th.

The investment seeks return linked to the performance of the S&P 500 VIX Short-Term Futures Index TR. The ETN offers exposure to futures contracts of specified maturities on the VIX index and not direct exposure to the VIX index or its spot level. The index is designed to provide investors with exposure to one or more maturities of futures contracts on the CBOE Volatility Index. Company description from FinViz.com.

The VXXB is a short-term volatility ETN based on the VIX futures. As a futures product it has the rollover curse. Every time they roll to a new futures contract, they have to pay a premium and that lowers the price of the ETN. It is a flawed product with a perpetual decline built in from the monthly roll over in the futures contracts.

As evidence of this flaw, the prior VXX ETN had done five 1:4 reverse stock splits. The last five reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16), $12.77 (8/22/17). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

We know from experience that the VXXB and its predecessor the VXX always decline long term.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETN and forget it. This will be a long-term position. This is not a 2-3 week play. I can guarantee you, if history holds, we can play this until it splits 1:4 again at $10. Once we are in the position and profitable, I may put a trailing stop loss on it. We will take profits and then look for a bounce to get back in. We could keep this play in the portfolio on a trading basis permanently.

The VXXB will be hard to short. The shares are out there and being traded because the volume on Thursday was 22.1 million. You have to tell your broker you really want to short it and make them find the shares. Sometimes it takes days or even a week before your broker will find you the shares. Trust me, be persistent and it will be worth the effort.

Position 2/1/19:
Short VXXB shares @ $35.33, see portfolio graphic for stop loss.